Sunday, February 23, 2014

Lesson #2: Assumptions and Constraints in Designing a Supply Management System

Continuing with our #ChickenMafia History Lesson series (see Lesson #1 for the beginning), today we learn about the limitations and consequences of designing a Supply Management system.

Continuing from where we left off in Lesson #1, Mr. A.G. Wilson next said:
“The legislation has many ramifications for agriculture on the prairies and indeed for the nation as a whole."
It appears that he refers to "unforeseen consequences", the boogey man of all governmental intervention.  Best intentions are not enough.  Governments tend to have lack of forethought and planning.  Lack of participation by the majority forces the voice of lobbyists to dominate the discussions (if there are any discussions at all).

For many stakeholders who suffer and plead for relief, there is justifiable frustration with the status quo, unbearable inertia and delay by the bureaucrats, followed by a double scoop of neglect by the politicians in serial sequence after the bureaucrats finally agree that something must be done, followed by panic and a rush to respond by jumping upon an incomplete or jerry-built band wagon. Sometimes that rickety bandwagon doesn't survive the long and challenging process to achieve royal ascent.  More often the misguided legislation collapses soon after passing, or careens off the road and over the cliff, taking all those on board to their tragic fate.

If all that is true, then what should be done with the current disaster of SM legislation at both Federal and Provincial levels?

Will we make an even bigger mess by trying to fix the current mess?  For one thing is sure with government action, as bad as it is today, the government can always make it significantly worse.

Let's continue:
"These ramifications can be placed in perspective by a review of developments in this form of legislation over time and the underlying reasons for passage of such a bill.  Such a review will also serve to explain the intent of particular sections of the bill which provides for the regulation of the marketing of farm products in interprovincial and export trade."
It always helps to understand the history behind how we got to today's disaster.  It helps to sooth the wounds, making our suffering more bearable.  Alternatively, it rubs salt into the wound, raising us up to a crescendo of pain that motivates us to cry out for immediate change. That urgency then reinforces government's hasty action and resulting folly, thereby repeating our downward spiral.

In spite of all this, we go on:
"Historical Background
Producers have long been concerned with their lack of bargaining power as individuals when marketing their products.  Early attempts to obtain bargaining power through the formation of “voluntary” cooperative marketing organizations met with limited success.  It was discovered that if bargaining was to be effective in raising price, control of supply was essential.  When members of a voluntary organization restricted marketings and raised price, the benefits accrued to those individuals outside the organization."
This speaks of unintended and non-obvious consequences.  It is not clear to me all the intricate mechanisms at work here.

To me, this is similar to taking the back off a mechanical watch.  I see the intricate mechanism of gears and levers actuating and turning.  I see the second, minute, and hour hands progressing in their steady pace.  However, I am unable to fully understand how it works, or why it was designed as it is.  I have no understanding of the designer's compromises and constraints that they had to overcome, or that the designer failed to address with the final product of their efforts ticking before my eyes.  I can only trust.

Mr. A.G. Wilson, the author of these words, seems convinced that it is all or nothing for supply management to work.  Let us see if, as Albert Einstein suggests, we can do a thought experiment to better understand the mechanisms at work.

Let's say that we have 50% of the farmers for a particular commodity (say, for instance, broiler chickens) convinced to stick together, have a 1-desk marketing body, and share the benefit and pain equally amongst all their members.  That co-op decides that prices are below what is reasonable, so the economics of supply and demand say that the total production of chicken must go down, or the consumption of chicken must be driven up, which will subsequently raise prices, relieving the farmers' financial pain.

The farmers' co-op then decides that all member farmers will cut their chicken production by 10%, and this should balance the supply-demand.  The downstream chicken processors can no longer get all the chicken that they desire from their regular supplier.  The processors start calling around, looking for alternatives, for reduced production creates a small base upon which to fund their fixed overhead costs, which will result in significantly lower profits if no solution is found.  Each producer finds a non-ideal alternative supplier, who can supply an inferior chicken, or a more expensive chicken due to the added shipping costs or less efficient upstream growing process.  The producer's profits shrink, so they will attempt to raise prices downstream.  If all or most suppliers are in the same boat, the average retail price of chicken will increase.  If the processor is unsuccessful in getting a retail price increase, they will suffer the lower profits until they can find a solution.

Remember that just 50% of the broiler chicken farmers are part of the co-op.  The other 50% of the farmers are independent actors who are looking out for their personal best interest.  What is their response as they observe the rapidly changing dynamic caused by the co-op's 10% production cut?

The independent farmers can choose to:

  • Do nothing different.  In this case, they will have the same production while the co-op cuts back, so they have automatically gained market share.  They will be getting phone calls from 1 or more processors asking if they can buy some chicken from the independent farmer to fill the supply gap.  The independent farmer will find it easier to sell all of his chickens, and it may fetch the same or higher price.  This encourages the independent farmer and provides him with more time on his hands (less time spent marketing), and possible a few extra dollars.  As the next growing period is planned, these independent farmers may choose to spend this extra time and/or money to grow some additional chicken.  This process continues again and again, until the co-op stops growing chicken, and the independent farmers have each doubled their chicken production.

  • Immediately raise prices.  When the co-op cuts production, the wise independent might assume that chicken will become a more scarce commodity, and therefore more valuable.  When the phone calls start to arrive, he is ready with a supply of chicken, but at higher prices.  The desperate producer negotiates as best they can, and possibly a sale occurs.  The independent farmer may have to adjust his price somewhat so as to be below the point of gouging the producers, but there are many more people interested in buying his chickens, so they eventually sell at the same or higher prices.

  • Immediately increase production.  This is the most aggressive tactic, and has the greatest risk.  Some of the co-op may be bluffing, saying they cut production when in reality they stayed the same, or possibly increased production to take advantage of the "silly" co-op members who were good to their word.  In this case, lack of co-op disciple could cause more, not less, chicken being produced, so that the co-op members, who already have the relationship with their customers, fully meet the needs of their traditional customers, some of the needs of customers previously supplied by fellow co-op members, and the independent farmer has more chicken which nobody wants.  If however, the co-op discipline is almost perfect, then the independent farmer has more chicken just when a shortage is created by the co-op.  This tends to prevent a retail price increase, or softens the amount of the increase.  With each additional chicken grow period, more and more independent farmers will choose this option as the rewards will likely outweigh the risks.

  • Reduce production in solidarity with the co-op.  It is unlikely that all of the independent farmers will make this choice.  Each independent farmer will eventually hear of the benefits accrued by those who raised prices or increased production to fill the gap created by the co-op.  If not in the first growing period, then eventually, virtually all of the independent farmers will learn what is in their best interest, and abandon this possibility over time.
So this mind experiment seems to indicate that the co-op farmers will loose big time no matter what the independent farmers choose to do in the short term.  In the long term, if the co-op is foolish enough to continue with its plan, each and every one of the co-op farmers will be driven out of the chicken business, or bankrupt (so that the former co-op farmer is out of all farming business ventures, not just chickens).

This mind experiment logic seems to confirm the statements by Mr. A.G. Wilson in his paper.

Let's continue:
"The experiences of the cooperative organizations formed under the influence of Aaron Sapiro in the 1920’s demonstrated the fallacy of attempting market control where the entire supply was not regulated."
It appears that Mr. Sapiro lead a group of farmers over the cliff in 1920's because of a poorly chosen strategy.  Game theory among 4 to 8 players around a table could have demonstrated the fallacy of his plan with just a few hours work, rather than destroying many farmers who were encouraged to "bet the farm" in real life as idealistic supporters of a cause.  Most unfortunate.

Continuing on:
  "Producers subsequently agitated for marketing legislation which would allow a majority to impose control over the total product."
Now here we have the tyranny of democracy.

One of the tests we have for such plans is to assume we have an independent country with just 3 citizens (A, B, and C).  Everybody gets 1 vote.  Mr. A by some random or skillful series of events, happens to have (or gain) more assets and/or skill and/or other valuable commodity than the other two citizens.  Human nature being what it is, Mr. B proposes that Mr. A will be nationalized and be taxed or have his property confiscated and divided equally amongst all citizens.  Of course, Mr. A will vote against this motion, but Mr. B and Mr. C have much to gain, so they vote in favor of the proposal, and it's 2 against 1, and the majority win in a democracy.  Perhaps there are even fewer scruples, and a motion is made to turn Mr. A into the slave of Mr. B and C.  Any minority can suffer terribly at the hands of the majority in an unconstrained democracy.

We can see that democracies must be tempered by the rights of the minority, or things get bad pretty quickly.

In our case, where a majority of farmers decide that all farmers no longer have the right to grow or sell their chickens as they please, violates the rights of those who do not voluntarily agree with this plan.  Even if there is just 1 farmer who disagrees, on what basis do all other farmers have the right to steal this one farmer's freedoms?

Tyranny of the majority, pure and simple.

Let's continue:
  "They considered that such legislation would enable them to obtain a higher price as a result of control of the total volume of product believing that higher prices were synonymous with higher incomes."
An interesting turn of the phrase, "believing that higher prices were synonymous with higher incomes."  It seems that Mr. A.G. Wilson suggests that this is an assumption that doesn't always (or never) comes true.

I can only think of one class of examples of this.  If there are alternatives to the controlled market, people who resent the control can go to these alternatives.  For example, if there is a monopoly on gasoline, prices could be increased more than what some people are willing to pay.  Fortunately, instead of using gasoline, people can use LNG, propane, diesel fuel, kerosene, fuel oil, wood gasification, electric, or other alternatives.  One or more of these alternatives will win as a result of people moving away from gasoline.

If a monopoly in domestic chicken is created, there is turkey, beef, pork, foreign chicken, or a number of other alternatives.

Perhaps there are additional assumptions in this sentence that all of you can suggest, in which case, make a comment below.

Continuing on:
  "Furthermore they believed that control of the product would allow the market environment to be influenced in a manner favourable to them.”
Ah yes, self interest.  The old saw, "What's good for GM, is also good for the nation." and all similar ones.  While this might be true in the short term, continuing too far down this road leads to arrogance and privilege, to the point that the organization loses its way, and a growing divergence of interest occurs.  Soon, what is good for the organization is totally opposite to the best interests of the nation.  What is the key moment where this policy should be stopped?  If it is only stopped when the interests are diametrically in opposition, there will be a huge shock to the systems (both inside the corporation, the shareholders, the customers, and the nation) when the switch is suddenly thrown.  Therefore it is best to never get started down this road.

Any time somebody proposes shared interests, run for your life, or ensure systems are built in to detect these future divergences, and immediately throw the switch as the slightest difference in interests.

Unfortunately, that wasn't done with Supply Management.

That is why a SM system that may have been in the best interest of Canada at one point in time, is no longer so, but it has the power and inertia to force a continuation of their monopolistic system as if it was still in Canada's best interest.

Lack of foresight by the government allowed for inadequate protection of Canada's consumers and Small Flockers.  Now, consumers and Small Flockers are suffering terribly at the hands of the monster created by the government.

It is the government's responsibility to reign in the SM monster they created, so as to relieve the oppression and tyranny against consumers and Small Flockers.

Let it be so.

No comments:

Post a Comment

Off-topic commercial spam that's posted so as to help sell your wares will be deleted.

On-topic comments, where you behave yourself and play nicely, will remain posted; whether they are pro or con. Everybody needs to fully understand all points of view so that we can find a solution that encompasses everybody's concerns. Give it your best shot.

If you decide to post, your posting becomes part of the public record, and SFPFC has full rights to use it (or not) in any reasonable manner or medium that suits our purposes.

Before posting, please proofread, and correct as necessary. If you subsequently discover a need to fix your previous posting, make an additional posting that refers to the original posting, then set the record straight.